Updated at: 06/09/2013 11:05 AM
By STEVE GARMHAUSEN
Money-market funds: You might know them as a safe place to park your cash and perhaps gather a tiny bit of interest in the process.
But in Washington, D.C., money funds have been the subject of high drama since the 2008 financial crisis. At issue have been years-long efforts by the Securities and Exchange Commission, Wall Street’s cop, to reform the rules under which these funds operate_in order to avoid investor panics of the sort that occurred a few years ago.
Those efforts have been dogged by opposition from the mutual fund industry.
Wednesday marked a milestone in the saga, with the SEC releasing proposed new rules for the industry. The commission’s intent: To help shield the financial system from shocks that could put the economy at risk. The details of the reform effort can get technical pretty fast. Here’s a Q&A overview of what’s going on:
Q: What’s the purpose of reforming the money-market fund industry?
A: Money funds are more than a safe place for mom and pop to put theirÂ cash. These funds have $2.6 trillion in assets, most of that from corporations, banks and governments. Corporations rely on the funds as a source of short-term financing, making them a major part of the machinery that keeps the country’s financial system running.
The effort to reform the industry’s rules springs from the 2008 financial crisis, when the risk of investor "runs" on money funds became clear. In September of that year, the oldest money fund_and one of the biggest_experienced a decline in value. That might not seem like a big deal, since mutual fund values fluctuate with the market all the time. But investors have long expected money funds to maintain a stable value of $1 per share. When the Reserve Primary Fund "broke the buck," dropping from $1 to 97 cents in value, investors panicked.
Within days, investors had yanked some $300 billion from funds similar to Reserve Primary, helping to bring the short-term credit marketÂ to a standstill. Companies struggled to find the funding needed to make payroll and meet other critical expenses. Only intervention by the Treasury Department, which offered to insure the funds, prevented a potentially disastrous chain reaction. Avoiding a replay of this scenario is the SEC’s goal.
Q: What is the SEC proposing?
A: The commission has put forward two proposals. The first requires the riskiest kind of money funds to switch from the current system, in which they use a "fixed" share price of $1, to a "floating" share price that fluctuates with the market. Money funds invest very conservatively, but the value of the assets they hold does, on rare occasions, move up and down ever so slightly.
Traditionally, when portfolio values have fallen, the parent fund companies have stepped in to prop up the value of the shares. The company that ran the Reserve Primary Fund was the exception_it didn’t have the resources to prop up the fund’s $1 "net asset value."
The idea behind the floating share prices, or floating NAVs, is to de-stigmatize changes in fund value. "The idea wasÂ to have the NAVs float, and train investors to understand that they’ll fluctuate," says John Rekenthaler, vice president of research at Morningstar, Inc.Â That, in theory, would make panics less likely. The floating NAV proposal would not affect the two safer flavors of money funds, known as retail and government funds.
The SEC’s second proposal attempts to more directly discourage investors from making runs on money funds. It envisions a stable share price but includes charging investors a fee for redemptions during times of stressÂ and giving fund directors the ability to temporarily suspend redemptions for up to 30 days.
The two SEC proposals may ultimately be adopted separately or combined into a reform package.
Q: To what extent would all this affect average investors?
A: With the proposal just unveiled, the industry is still deciphering what its impact might be. Even if certain funds’ NAVs end up floating, their range of volatility is expected to be minimal. But Jerry Klein, managing director at HighTower’s Treasury Partners, worries that such a change could for technical reasons make money funds more difficult to use in overnight bank "sweep" accounts.Â In sweep accounts, money is moved from a cash account to an investment account overnight in order to earn a small return.
In addition, investors who don’t have gains and losses to report under the fixed-NAV model, in some cases, may be required to report even tiny gains for tax purposes, he says.
It’s important to note that at this stage, the proposals are just that--proposals. Up next is a public comment period, which could lead to revisions. The money-fund industry is certain to weigh in vigorously. The last thing that it needs is to lose more investors. In part because of the 2008 scare and in part because of paltry yields, money-fund assets have plunged from $3.9 trillion to $2.6 trillion over the past three years.
There’s no pressing need for investors to decide whether to move their money to alternative investments or stay put: Klein predicts that the earliest the SEC commissioners would vote on the proposals would be late this year.
(Copyright 2013 by The Associated Press. All Rights Reserved.)